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Hidden by the stock market’s solid first half of the year is a dumpster’s worth of beaten down blue chips with dividend yields as high as 7.3 per cent.

Talk about diversification – the roster of high-yielding blue chip dividend payers includes pipelines, banks, telecoms, utilities and energy stocks. High yields are a byproduct of depressed share prices, which suggests investors should be wary. But for whose who understand the risks, there’s an opportunity here to capture both a high yield and some degree of future dividend growth.

We are living in bountiful times for investors who prioritize income. For the safety-first crowd, there are guaranteed investment certificates (GICs) and federal government treasury bills (T-bills) with yields in the 5-per-cent zone. Climb a rung on the risk ladder and you can find slightly higher yields from preferred shares and corporate bonds. Step up another couple of rungs and you have out of favour blue-chip dividend growth stocks.

Late this week, Enbridge Inc. ENB-T and TC Energy Corp. TRP-T had yields above 7 per cent, Bank of Nova Scotia BNS-T, Pembina Pipeline Corp. PPL-T, BCE Inc. BCE-T and Canadian Imperial Bank of Commerce CM-T were above 6 per cent and Manulife Financial MFC-T just below.

To make sense of these yields, you need to compare them with the risk-free rate of return available today on T-bills and GICs. “Visualize blue chip stocks as a 7-per-cent yield minus 5 per cent,” said Srikanth Iyer, Lead Portfolio Manager and Managing Director, and Head of i³ Investments™ for Guardian Capital LP.

The extra two percentage points are the risk premium associated with generating yield from a stock as opposed to a T-bill or GIC. Mr. Iyer said the risk premium is your compensation for share price volatility and the risk of a dividend cut.

Yields in the 6-per-cent to 7-per-cent range for blue chips are exceptional and suggest a degree of investor concern about the security of the dividend. Mr. Iyer rates the risk of a dividend cut for the likes of Enbridge, TC Energy and BCE as very low. “I own Enbridge – not at the point of crazy weightings, but around 3 per cent.”

Dividend cuts by big blue companies are rare, but you can’t dismiss the possibility. The most recent example is Algonquin Power and Utilities Corp. AQN-T, which reduced its cash payout by 40 per cent earlier this year. Other examples from the past include TC Energy back in 1999, when it was TransCanada PipeLines, as well as Telus Corp. T-T in 2001, Manulife in 2009 and SNC Lavalin SNC-T in 2019. Energy and mining companies have also cut dividends, but that’s not unusual in cyclical sectors.

For investors seeking income ahead of capital gains, beaten-down dividend stocks offer the potential for both a high yield today and dividend growth in the year ahead. But the pace of dividend growth has slowed for many of today’s high-yielding stocks.

Globe Investor reports a five-year average annual dividend hike of 5.9 per cent for Scotiabank, but the latest increase came in at 2.9 per cent. In cash, the payout rose three cents to $1.06. Enbridge has a five-year dividend growth rate of 7.4 per cent, but the most recent increase came in at 3.2 per cent. That’s still close to the latest inflation rate of 3.4 per cent.

Mr. Iyer said dividend growth overall in the Canadian market has been resilient in recent years. But he sees more potential for growth from middle- to larger-size companies than what he refers to as mega-capitalization companies.

If dividend growth prospects are modest from these mega-cap stocks, what about capital gains potential? There’s some urgency to this question, given that some mega-cap dividend stocks are worth less than they were five years ago. Globe Investor late this week reported a five-year loss of 11 per cent for TC Energy, 11.1 per cent for Pembina Pipelines and 14.9 per cent for Scotiabank.

For Mr. Iyer, a decline in interest rates would be the big fix for beaten down mega-cap dividend payers. “I think they will at least go up 30 to 40 per cent,” he said. “It’s going to be a wildebeest migration.”

Mr. Iyer sees particular rebound potential in utilities, a defensive sector regarded as a proxy for bonds, and banks. Banks offer solid dividend-growth potential as well. He cited forecasts, derived with the help of artificial intelligence, that payouts will rise by 4 per cent to 5 per cent.

Beyond banks, Mr. Iyer’s AI forecasts suggest food and beverage companies, renewable electricity producers and real estate investment trusts in the retail sector as offering the best dividend growth potential. One additional sector Mr. Iyer singled out is energy. High-yielding energy mega-caps include Suncor Energy (SU-T) and Canadian Natural Resources (CNQ-T), with yields of 5.3 per cent and 4.7 per cent, respectively.

“The oil sector is growing its dividends, its balance sheet is lean and its ESG score is improving,” he said. ESG stands for environmental, social and governance. “It’s much more investor friendly than it’s ever been.”

Follow Rob Carrick on Twitter: @rcarrickOpens in a new window

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